Conventional wisdom that active managers cannot outperform the S&P 500 is “fundamentally wrong”, according to Baillie Gifford’s Kirsty Gibson, who says the US market is “wonderfully inefficient”, adding: “This is not just our opinion. This is fact.”
The manager can back up her contention with data. While just 19 of 86 funds in the IA North America sector have beaten the S&P 500 over the past decade, her Baillie Gifford American fund has significantly outperformed over three, five and 10 years.
Performance of fund vs sector and index
Source: FE Analytics
Since inception a little under 20 years ago, it is up 775.55 per cent compared with 416.65 per cent from the index.
Performance of fund vs index since inception
Source: FE Analytics
Gibson said there are three fundamental pillars to this long-term outperformance, the first of which is the fund’s time horizon.
“Our portfolio has a low turnover of 15 to 20 per cent per year, whereas the average in the US is probably at least 100 per cent per annum, if not more,” she explained. “We look to hold on to stocks for long enough so that the characteristics of their business model shine through to the share prices.”
A second fundamental pillar is being genuinely active – Gibson said it may sound obvious, but in order to beat the index, you need to be different from it.
“Our active share is around 90 per cent,” the manager continued. “We run a concentrated model, where we are willing to hold our highest conviction ideas in size. I think our largest holding is Amazon, which is over 9 per cent of the fund.”
Active share of fund vs index
Source: Baillie Gifford
The third fundamental pillar is growth.
“We are out-and-out growth investors, we run a high-growth portfolio. We look for what we call the rare exceptional growth companies and we aim to hold them long enough to gain the upside. We believe the opportunity to identify and invest in these great growth businesses is as strong as ever.”
Yet, this third pillar may be problematic for new investors at this stage of the cycle.
The MSCI World Growth index has significantly outperformed its value counterpart over the past decade, but the value style of investing tends to win out over the extreme long term and many analysts believe a reversion is due.
Performance of indices over 10yrs
Source: FE Analytics
In an article published on FE Trustnet late last year, Schroders’ Simon Adler said that while growth stalwarts will claim the technological advances since the turn of the millennium have changed the game, the 120 or so years before then – the longest data series available in investment markets – saw its fair share of disruption as well.
“During that period you had the Boer War, two world wars, the invention of the motorcar, the invention of the commercial plane, the invention of the internet, the space age and the Cuban missile crisis where we nearly went to a nuclear war,” he said.
“And throughout all of that, value has still prevailed over the long term.”
However, while Gibson (pictured) accepts the sceptics’ argument that every generation believes it is special, she said we are currently seeing a convergence of multiple forces that will lead to a prolonged period of disruption
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The manager added that while some of these forces are well known – such as data harvesting on the internet – one that is less well documented is the relationship between supply and demand, with the latter constantly changing at the individual level.
“Amazon’s CEO Jeff Bezos spoke last year about an ever-growing ‘divine discontentment’, the idea that consumer expectations are never static, they just keep going up,” she explained.
“A really good example is the internet and how it used to be. I remember as a child, when you first connected to the internet, you used to have to make sure no one was on the phone, then you put on the dial-up tone which would go on for three or four minutes, then it would connect and then each website took 10 or 15 seconds to load.
“Yet now you see people on a train and if the website doesn't load instantaneously, they get really, really annoyed.”
“This is this idea that your expectations are increasing and we increasingly demand more from what we see.”
Another force acting on demand is hyper personalisation, whereby people are becoming used to customising every area of their lives to their exact specifications. This is demonstrated in the rise of virtual systems – for example, the Echo Dot was the best-selling item across all product ranges globally on Amazon in the fourth quarter of last year.
“Searching for answers by typing words just doesn't seem to be enough for us, it's not convenient enough anymore,” Gibson continued.
“We want to ask questions verbally and we want the answers to be announced to us.”
“And on the supply side, well, suppliers are leveraging innovative technologies and business models to meet that demand that consumers are driving in ever more granular ways.”
An example of such a business in Baillie Gifford American is recent purchase Yext, which Gibson describes as “a single source of truth provider”. This means it helps ensure information such as a company’s opening times are correct across all the platforms it might be exposed to, such as Google, Facebook, Yelp and TripAdvisor.
Gibson said this is particularly important in a voice-search world, where only one answer is provided and people don't scroll through numerous pages.
“Ultimately if you're a brand, you need the answer to be correct,” she added. “Because if it's not correct and somebody rocks up at your restaurant on the day that you're shut, they're not going to be very impressed and they are less likely to try it out again.”
The manager said the most exciting thing about the disruption we are witnessing today is the opportunities aren’t necessarily reliant on economic growth, more consumer spending, or even larger addressable markets.
Instead, it is the growing opportunity for new and old companies to meet ever-changing consumer demands in a more refined and dynamic way
“If the addressable market is sufficiently large, companies who meet customers’ changing lives will be able to grow by being able to steal market share from others for decades,” she continued.
“The success of companies like Amazon and Google in addressing consumer demand effectively has trained customers to want more from other walks of life, through seeing increasing disruption in areas beyond the traditional kind of retail and media, through to areas like healthcare or financial services.
“These companies continue to disrupt the status quo and as they do, so, there will be volatility in share prices. This is the norm, not the exception. But this disruption is what's driving structural change. And that's what makes being a growth investor in the US very exciting.”
The £2.2bn Baillie Gifford American fund has ongoing charges of 0.52 per cent.